Can investors capitalize on Europe’s rock bottom interest rates?

A widening gap between interest rates in Europe and the United States is presenting global real estate investors with a potential opportunity.

October 08, 2018

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A widening gap between interest rates in Europe and the United States is presenting global real estate investors with a potential opportunity.

In the U.S., rates were recently hiked from 2 to 2.25 percent, while European interest rates are currently locked at zero percent. While ultimately heading up over the next five years, Europe’s rates are likely to remain locked until next summer, keeping them further away from rates across the Atlantic and closer to home in the UK.

With more UK and U.S. rate rises are on the horizon, the two countries will be in a different interest rate environment to their eurozone peers and pulling away from eurozone borrowing costs. That puts leveraged buyers of eurozone real estate, as well as those with refinancing on the horizon, in a comfortable position.

“It’s a considerable gap of up to 30 months,” says Marcus Lütgering, head of office investment for JLL Germany. “It’s a significant gap for international real estate investors.”

In Germany, the steps taken by the U.S. Federal Reserve in recent months are having a positive impact on real estate investment, says Lütgering.

“As a result of this spread, Germany is currently a particularly attractive location for international investors looking to use leverage or refinance existing debt.

“It’s lower for even longer.”

Normalisation
Where rates are rising, the measured and clear path of normalization taken by the U.S. and the UK should aide investment decision-makers. When European rate rises do eventually begin, they are expected to be managed gradually.

In the case of the UK, the Bank of England’s interest rate hike from 0.5 percent to 0.75 percent in August – only its second in 10 years – was not unexpected. Any further interest rate rises are likely to be “gradual pace and at a limited extent”, the BOE said. Mark Carney, the BOE’s Governor, believes UK monetary policy needs to “walk – not run – to stand still”.

And real estate investors have appreciated the sense of steadiness, with little if any reaction to August’s pre-empted rate rise noted in UK real estate.

“The BoE’s rises have been so carefully planned and significant impact for real estate investors in the UK has been avoided,” says Robert Stassen, Head of capital markets research at JLL. “It’s been absorbed.”

However, in the U.S., interest rate increases – carried out in 25 basis point steps since March 2017 – have had an impact on real estate, Stassen points out.

“Direct real estate investment slowed there as a result of Fed policy,” he says. “However, impact on pricing was fairly limited.”

Lower than low
The European Central Bank remains caught between political uncertainty and its own quantitative easing program, as well as rising inflation and positive economic data.

“When you look at Italy and the fact that Greece is by no means out of the woods when it comes to over indebtedness, it’s hard to foresee any upward moves by the ECB in the near future,” says Lütgering. “If we want to keep the euro – and there can hardly be any doubt about that given the general political climate – we will have to continue to support the over-indebted member states with a low interest rate.”

Rooted at zero, the ECB lending rate, says Stassen, does not allow the central bank much room to apply any emergency measures. Essentially, it lacks “a few tools in the box” in the event of any major political instability, accelerating inflation or falling currency values, as is the case with Turkey. Moves such as the UK’s BOE rate cut two years ago – due to the vote to leave the European Union – are harder to make from the low point the ECB rate currently finds itself at.

“The ECB could entertain the idea of going up to come down but first needs to stop its quantitative easing program,” says Stassen. “A more likely scenario is that at some point later next year, rates are moved slightly as a reaction to inflation and more economic growth across the eurozone.”

How property yields move is not dependent on interest rate movement. However, as Stassen points out, at a certain point rising bond rates could put upward pressure on yields. A slight fall in prime capital values is conceivable, according to JLL research.

“Investors’ expectation of rental growth and the weight of capital targeting real estate should ease any impact of yield movement,” says Stassen.

Disparity between eurozone and U.S. and UK rates is already a reality. With the interest rate peaks of this cycle likely to be lower than in the past, and some sense of predictability in place, Stassen says investors should feel relatively confident when planning ahead.